On the interpretation of price-quality relations

Abstract

While low price-quality correlations are commonly cited as evidence of markets which are in some way inefficient, we argue in this paper that price-quality correlations do not necessarily reflect the degree of efficiency of a market. We first define a measure of market efficiency as the aggregate amount which consumers lose due to not choosing the maximum utility brand. Given this measure, and a model of consumer search behavior, we demonstrate analytically that losses in a particular market depend on the distribution of prices and qualities, on the number of alternative brands, and on the level of search costs, as well as on the price-quality correlation. We construct several numerical examples which demonstrate that losses need not be closely related to price-quality correlations.